Chapter 9 (MR & MC) Flashcards
Marginal revenue
- Additional revenue from more sales or from selling one more unit
- marginal revenue depends on market structure (how competitive an industry is) and whether a business is a price taker or price maker
- MR = P for Price taking business in perfect competition
- MR < P for Price making businesses in all other market structures
One Price Rule
Products easily resold tend to have a single price in the market
- MR<P for price makers so when a price making business lowers price, it must lower price on ALL units sold, not just new sales
Marginal Cost
- as output increases marginal cost increases for businesses operating near capacity or when businesses additional inputs cost more.
- marginal cost is usually CONSTANT for businesses not near capacity
Diminishing Returns
- as output increases, decreasing productivity increases marginal costs
Recipe for Max Profits
- first looking at the quantity decision then the price decision
- for each quantity, compare MR & MC
- if MR > MC, total profits will increase. Stop increasing quantity when MR < MC
- once you choose the TARGET quantity with max profits, set the HIGHEST POSSIBLE PRICE allowing you to sell the target quantity
- the intersection of the MR curve and MC curve is the KEY to the recipe for max profits
Price discrimination
Charging different customers different prices for the same product or service
- breaks the one-price rule and is possible only when a business can:
1. Prevent low price buyers from reselling to high price buyers
2. Control resentment among high price buyers
Elastic demand: lowers prices
Inelastic demand: rise prices
- most examples of price distribution involve services which cannot easily be resold
- price discriminating business eliminates MR and MC for each separate group, then sets prices allowing the sale of all quantities for which MR>MC
Price discrimination increases profits by
- Charging lower price to elastic demand group (lower willingness to pay)
- Charging higher price to inelastic demand group (higher willingness to pay)
Max Profits in Perfect Competition
Perfect competition with price-taking business, is an EFFICIENT market structure:
1. Businesses just earn normal profits and economic profits are 0
2. Maximum total surplus
Max profits in all other market structures
All other market structures with price-making businesses are INEFFICIENT:
1. With the same inputs, businesses reduce output and raise prices
2. Businesses earn economic profits
3. Total surplus < perfect competition because of deadweight loss from reduced output
Benefits to market structures with price making power and economic profits
- product variety
- economic profits finance innovations and creative destruction, improving living standards for all